"Passive" Directors Beware

Against a backdrop of high inflation, ratcheting interest rates and increased energy costs, the number of corporate insolvencies is expected to rise over the medium term. According to the latest statistics published by Deloitte the total number of corporate insolvencies in Ireland in 2022 passed 500, representing a substantial increase of 30% from the same period in 2021. These figures indicate that the previously forecasted increase in insolvency activity is becoming a reality, with insolvency activity expected to continue to rise during 2023.

With this is in mind, it is timely to remind all company directors, including non-executive directors, of their fiduciary duties and statutory obligations as officers of companies under the Companies Act 2014 (“the Act”), particularly when a company is facing financial challenges.

Section 228 of the Act sets out that a director shall

(a)act in good faith and in what the director considers to be in the interests of the company and
(b) act honestly and responsibly in relation to the conduct of the affairs of the company.

In the context of companies facing financial distress, directors have an additional duty to creditors, when they know or ought to know the company is in financial difficulty, irrespective of whether they actively participate in the day-to-day operations of the company.

The introduction of the European Union (Preventive Restructuring) Regulations 2022 (SI 380/2022) (“the 2022 Regulations”) on 29 July 2022 imposes an additional statutory obligation on directors to have regard to the interests of the company’s creditors, where directors become aware of the company's pending insolvency. Regulation 4 of the 2022 Regulations amends the Act by the insertion of a new Section 224A, which places a statutory duty on directors to consider certain matters where the company is, or is likely to be, unable to pay its debts.

The insertion of section 224A marks the first time a statutory duty has been imposed on a director to have regard to the interests of creditors. While section 224A has imposed new statutory duties on directors, those duties already existed in substance by way of common law duties.

Any director found to have acted irresponsibly or dishonestly in the course of a Liquidator’s investigations into the affairs of the company could face prosecution under Section 819 of the Act. Under Section 819 of the Act, directors of insolvent companies could be restricted from acting as a director or secretary of a company for a period of 5 years. Directors could also find themselves the subject of a disqualification order under Section 842 of the Act, depending on the outcome of the Liquidator’s investigation into the affairs of the company and the course of action determined by the Corporate Enforcement Authority.

A recent Court of Appeal decision in the matter of Alvonway Investments Limited (In liquidation) v O’Donovan, O’Brien and Appelbe, highlights how important it is for all directors, including non-executive or “passive” directors, to keep fully themselves informed of the company’s affairs in order to comply with their fiduciary, now statutory, obligations under the Act.

By way of background Mr Appelbe was one of three directors of Alvonway Investments Limited (the “Company”).

The liquidator sought an order for disqualification against Mr O’Donovan and restriction orders against Mr Appelbe and Mr O’Brien. Mr Appelbe subsequently appealed the restriction order made against him.

The grounds upon which the application was originally brought by the Liquidator related to the making of payments by the company to Mr O’Donovan and to a firm of accountants the day before a statutory receiver was appointed to the company by NAMA.

Whilst the Liquidator accepted that Mr Appelbe did not have any direct involvement with the specific payments, the Liquidator argued that Mr Appelbe’s lack of knowledge of the transactions amounted to irresponsibility within the meaning of section 819 of the Act. The Court was satisfied that Mr O’Donovan was the sole director responsible for the specific payments and Mr O’Donovan consented to a restriction order against him, in lieu of a disqualification order.

With regard to the two remaining directors, the Liquidator argued that in their role as directors they ought to have been aware of the company’s insolvent position at the time of the payments and ought to have ensured there was sufficient oversight and control in place to prevent the payments being made at that time.

Mr Appelbe argued that he had “little knowledge” of the company’s management prior to the appointment of the statutory receiver and after the appointment, NAMA “deprived” him of information regarding the affairs of the company.

Mr Appelbe’s contention that he had “little knowledge” of the company’s affairs revealed his “fundamental misunderstanding” of the serious nature of the duties of directors. His “lack of action” could not be used as a means of defence. The onus on directors under section 819 is to provide evidence of acting responsibly. The High Court restricted Mr Appelbe for a period of five years. In contrast, Mr O’Brien demonstrated to the Court that he acted responsibly and that he had a certain degree of knowledge and understanding of the company’s business. As such the Court did not feel there were sufficient grounds to restrict Mr O’Brien.

In the court of appeal Mr Appelbe argued that the Liquidator had not put forward sufficient evidence to demonstrate that he had a case to answer and secondly, Mr Appelbe argued that he could not be considered to have been irresponsible because he had never been “called upon” to engage in the affairs of the company. Essentially, Mr Appelbe argued that his status as a “passive” director was a defence to a restriction application. The court disagreed.

The Court of Appeal held that the appellant provided no information in relation to the role he played in the company. He provided no evidence to demonstrate that he informed himself of the company’s affairs at any time. The court held that it was not a question of whether the liquidator made out a case for Mr Appelbe to answer, rather once a restriction application is made in the context of insolvency, the onus is on the director to demonstrate he acted honestly and responsibly in relation to the affairs of the company. Mr Appelbe’s argument that he was never “called upon” to engage in the affairs of the company confirmed to the court that a restriction was warranted, rather than absolving him.

The judgment of the Court of Appeal emphasises that the role of a director requires active engagement in a company and reaffirms the position that a plea of ignorance will not absolve a non-executive or “passive” director of their responsibilities under the Companies Act. It is imperative that directors, even if not involved in the day-to-day running of the company, keep abreast of company affairs.